Pro Perspectives 5/5/23

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May 5, 2023
 
We talked about regional banks and commercial real estate yesterday (here). 
 
The regional bank ETF, KRE, was the best performing (unleveraged) ETF on the day, up 6.4%.
 
We also talked about the year-to-date underperformance in the broader stock market, relative to the big and mega cap tech.  Today, the strength in stocks was broad-based.
 
Was it the strong jobs report — another record low unemployment rate, in the face of 500 basis points of tightening over the past year?  
 
I would say, don't underestimate the significance of the WHO's official ending of the global health emergency.  
 
That's 38-months from date they declared the emergency.  Biden called the end to the U.S. national emergency last month.  And U.S. public health emergency is due to end next week, May 11.  
 
And remember, it was the WHO, declaring the clear global health crisis a pandemic, back on March 11 of 2020, that set all of the government "special powers" into motion.
 
And, importantly, corporate America took marching orders from the WHO and CDC for the past three years.  
 
Now we're finally at official end point.
 
This should bring to an end, any remaining debt or eviction moratoriums.  Student loans are due to restart the first of July.
 
With the "emergency" guardrails removed from the economy, which may expose more of the pain from the reset in prices and interest rates of the past three years, we may find that companies will regain their leverage over employees, getting them back to work in-person. 

Pro Perspectives 5/4/23

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May 4, 2023
 
Let’s take a look at some charts …
 
The Nasdaq is up 15% year-to-date.  The S&P 500 is up 6%.  But as you can see in this next chart, when adjusted for market cap (if we equal weight the S&P 500), the stock market is flat on the year.  
Similarly, the yellow line is excludes the top 100 market cap stocks in the S&P 500.  It’s flat. 
 
Where’s all the performance?  
 
Below is the FANG+ Index, which includes Meta, Apple, Amazon, Netflix, Microsoft, Google, Tesla, Nvidia, Snowflake and AMD.  It’s up 35%!
What should we attribute this outperformance?  In the post-covid environment, these stocks soared on easy money, and multiple expansion.  And when the switch finally flipped on the policy cycle, these stocks were punished, as the valuation models were introduced to the concept of an interest rate — multiples contracted. 
 
But why the snapback rally this year, despite what has been a continuation of the tightening cycle?  Is it anticipation of the end of the cycle?  Or does it reflect the market acknowledgement of consolidation of power in the economy, allocating to  market dominance?
 
Let’s take a look at the regional banks.  
As you can see, this ETF is trading back toward covid-era levels.  
 
We’ve looked at the commonalities in the bank failures to this point.  It remains contained to specialty banks, with the most extreme duration risk, and significant exposure to volatile venture capital, startup, and in cases, crypto deposits.
 
On that note, the fear of regional bank shareholders, and the motivation of short sellers, seems to be surrounding the concept of a “next shoe to drop” in commercial real estate (CRE). 
 
Moody’s has some research on this, calling fears of the commercial real estate market reliance on small and mid-size banks “overstated or misstated.”  What about small and mid-size bank exposure to CRE defaults?  At a worst case scenario, where asset values fall by 40%, they see the average CRE loan loss at 8%.  They see “a manageable downcycle for the CRE sector and its lenders.”  Probably a dip to buy in this ETF. 

Pro Perspectives 5/3/23

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May 3, 2023
 
The Fed hiked another 25 basis points today.  That takes the Fed Funds rate to the 5%-5.25% range.
 
In the press conference, Jerome Powell, once again, made a good case for why they should have done nothing.
 
He said "policy is tight."  He said "real rates are around 2%, meaningfully higher than the neutral rate."  That's clearly restrictive territory. 
 
And for a guy that has spent the past year trying to kills jobs, as a means of controlling inflation, today he says "it's possible that this time is really different."  In that, he meant that the job market can cool, as in the evaporation of 1.6 million job openings since the beginning of the year, and yet unemployment can still hang around record lows.
 
So the Fed is at 5%.  Along that path of rising global interest rates, we had a near sovereign debt crisis in Europe, that was fixed by another emergency European Central Bank bond buying program.  We had a near insolvency in UK pension funds, that was fixed by Bank of England government bond buying intervention. 
 
And now we've had bank failures in the U.S., that have been fixed by coordinated action from the Fed, Treasury and the big banks.  About this, Powell says that "financial stability tools and monetary policy are working well together."  The manipulate and fix strategy is going well, he says.  
 
We may see that in practice, again, before the week ends.  Shortly after the Fed meeting, we find that another bank is on the ropes.  It's PacWest.  Remember, from my note yesterday, the three banks that have failed over the past six weeks are not typical regional banks, but rather, specialty banks. 
 
PacWest is effectively Silicon Valley Bank by a different name. 
 
PacWest acquired Square1 Bank back in 2015.  Square1 was the east coast version of Silicon Valley Bank.  It banks venture capital firms and their portfolio companies. 
 
Now, perhaps more important than all of this, is the drone attack on the Kremlin overnight.  While the mainstream media is debating the validity, let's look at what markets are telling us. 
 
In a war escalation scenario (global war), we would see global capital move to relative safety.  That would mean, U.S. Treasuries (up), gold (up) and the dollar (up). 
 
Treasuries are indeed up (yields down).  Most notably, gold is challenging the record highs again (up $100 from the lows of Tuesday).  But the dollar isn't participating, yet … nor is oil (which should rise on war escalation).
 
For my Billionaire's Portfolio members, please keep an eye out for an update from me on the portfolio. 

Pro Perspectives 5/2/23

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May 2, 2023
 
After JP Morgan took over First Republic Bank yesterday, Jamie Dimon said "the banking system is very stable … there are only so many banks that were offsides this way … there may be another small one, but this pretty much resolves them all … this part of the crisis is over."
 
Remember, he's not just speaking from an industry perspective, as CEO of the biggest bank in the country, he's in in the conversations with the Fed Chair, Treasury Secretary, White House economic advisors and regulators in times of crisis in the financial system.
 
Despite the statement from Dimon, the short sellers went after the regional banks today.  This, driven by the thesis that the vulnerabilities in Silicon Valley Bank, Signature Bank and First Republic Bank were canaries in the coal mine — just an early warning of the vulnerabilities in regional banks.
 
But these three banks had a lot more in common with each other, and a lot less in common with regional banks, broadly.  
 
They all had very high percentage of deposits that were uninsured (balance greater than the FDIC insurance limit).  In large part, that had to do with banking venture capital firms, and the ultra-high net worth — but mostly this is about banking venture capital firms.  And just as a kicker, SVB and SBNY also banked crypto firms. 
 
These were all, what I would call, specialty banks.
 
And you'll see what else these three banks had in common in this next table …  
These three banks had the highest duration risk.  This becomes especially problematic when the securities they intended to hold to maturity have lost significant value — which they have, thanks to rising interest rates (rates up, bond prices down).  When forced to sell, to fulfill depositor demand for cash, they sell at a loss.
 
Interestingly, the fourth bank on this list (with high duration risk) had this to say:  "East West is a very different bank from both SVB and Signature, which has substantial concentrations in volatile venture capital and crypto deposits." 
 
This statement was from March 12th.  They knew early on, it was the unique specialty banking feature that was driving these bank failures. 
 
East West lost only 2% of deposit assets in Q1, and by their April earnings call, had trimmed the percent of uninsured deposits down to 41%.
 
With all of the above in mind, the short sellers are looking for more blood, hoping that dominos are lined up to fall in regional banks.  But the evidence doesn't fit the narrative.
 
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Pro Perspectives 5/1/23

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May 1, 2023
 
We have the Fed on Wednesday. 
 
They’ve raised 475 basis points in thirteen months.  And the market is pricing in a better than 90% chance that they will go another 25 basis points this week.
 
This, despite the banking shock of the past six weeks, which has now claimed a third victim. 
 
Remember, after hiking in March, on the heels of two bank failures, Powell actually made a strong case in his post-meeting press conference that they should have paused.  He talked a lot about the credit tightening that they thought was “quite real.”  In fact, he said directly that the banking stress, and related credit tightening, has an equivalent effect of a rate hike, and will weigh on inflation.
 
Well, we got the Fed’s favored inflation number this past Friday — the March reading.  It held pretty steady at 4.6%.  Even if we annualize the average monthly change of the past six months, it’s 4.2%.    
If we take that inflation data into account, and give a heavy weighting to market sentiment, we should expect the Fed to go forward with another 25 basis points on Wednesday. 
 
They’ve clearly made an effort to set the expectation.  The market has taken the “guidance.”  So that becomes the path of least resistance.
 
But if the discussion in the post-meeting press conference is not about pausing, it will be a negative surprise for markets.  
 
With the above in mind, the level of interest rates has proven to break things in the financial system. 
 
A hike on Wednesday will take the level another step higher. 
 
That said, by now we should know that the major central banks in the world have coordinated to normalize monetary policy — and have agreed, in coordination, to intervene, when necessary, to fix what they break. 
 
And these interventions have a solid record of marking the bottom in stocks (and sentiment).  
Remember, we looked at this chart of the S&P back in March 10th, after the big run on Silicon Valley Bank.  This chart is a snapshot on that Friday afternoon. By Sunday night, the Fed stepped in, promising to provide liquidity to depository institutions to backstop deposits. 
 
Intervention.
 
The bottom in stocks was marked the next day. 
 

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Pro Perspectives 4/28/23

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April 28, 2023
 
As we end the week, and month, let’s take a look at the performance of global asset prices year-to-date.
As you can see, stocks are hot.  Not just domestically, but globally. 
 
Remember, going back to 1950, there has never been a 12-month period, following a midterm election, in which stocks were down.
 
And the average one-year return, following the eighteen midterm-elections of the past seventy years, was +15% (about double the long-term average return of the S&P 500).
 
We’re five months removed from the midterm election, and the S&P 500 is up just over 12%. 
 
Related, we knew coming in that we had two important positive catalysts for stocks:  1) The rate-of-change in monetary policy tightening would slow dramatically this year (which it has), and 2) the rate-of-change in the fiscal policy madness would be zero (if not reversed), with a split Congress.  Gridlock.
 

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Pro Perspectives 4/27/23

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April 27, 2023
 
The first estimate on Q1 GDP came in this morning.  It was weak.  In fact it was spot on with the recent adjustment in the Atlanta Fed's model (1.1% growth).
As you can see in the graphic above, this model was tracking north of 3% growth for the quarter, before the bank shock of last month. 
 
With this in mind, the Fed has wanted to see a slowdown in economic growth, and a loosening of the labor market, as a means to ensure inflation is on a sustainable path lower.  
 
Well, they now have economic slowdown.  Growth has gone from 3.2% in Q3 of last year, to 2.6% in Q4, to 1.1% in Q1.  That 1.1% is well below long-term trend growth (3+%). 
 
They've gotten some job losses, particularly in the over-staffed tech sector.  The number of job openings (which Jay Powell has specifically referenced) has dropped by 1.3 million jobs since December (probably related to tech).
 
The important inflation number comes tomorrow morning.  It's the March core PCE.  This measures the change in prices of goods and services that people have actually paid — not just a selling price. "Core," means excluding food and energy prices.  And this March number will incorporate the fear, albeit brief, surrounding the safety of bank deposits.
 
The last reading was at 4.6%, year-over-year change.  This is the number the Fed wants to see back toward 2%.  But importantly, it's lower than the current Fed Funds rate, which should be applying downward pressure on inflation. 
 
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Pro Perspectives 4/26/23

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April 26, 2023
 
As we discussed yesterday, there is renewed pressure on First Republic Bank – the still standing, but still troubled bank that was exposed in the banking shock of last month.
 
With that, when the Fed releases it's weekly report of securities holdings tomorrow, we'll find out if this renewed stress results in another impulse of Fed balance sheet expansion.  
 
Below is what the Fed's job of "lender of last resort" looks like when they have to provide liquidity to a banking system that's having or fearing a liquidity shock.  In this case, it was a depositor run on a few banks last month.    
The Fed stepped in and plugged the gap with "loans." And, in coordination, the Fed and Treasury implicitly assured the safety of deposits in the banking system, but stopped short of an explicit emergency guarantee of all deposits (to include uninsured depositors beyond the failed Silicon Valley Bank and Signature Bank).
 
But, while the two banks that failed last month, and the teetering First Republic Bank, share(d) commonalities of an unusually high percentage of uninsured deposits, and an industry high duration mismatch (between asset and liability maturities), the real culprit in this meltdown was the depositor panic.  Moreover, how quickly it spread through social media.
 
All of that said, arguably, the trigger was the Fed's tone-deafness to the stress it has created from this tightening cycle.  That said, the interest rate market is pricing in about a 75% chance of, yet another, Fed rate hike next week. 
 
But we have a Q1 GDP report tomorrow, which looks like it will come in lower than had been projected now, given the downgrade in today's updated Atlanta Fed model (was +2.5%, now +1.1%).  And this appears to be driven by the lower revisions to January and February retail sales data (revisions that were released on Tuesday).
 
So this sets up for a negative surprise tomorrow.  And then we have the Fed's favored inflation gauge, core PCE (monthly, March), on Friday. 
 
This, while First Republic will likely require more attention from the Fed, FDIC and Treasury.  This may all be setting up for a positive surprise from the Fed next Wednesday (i.e. a pause). 
 
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Pro Perspectives 4/25/23

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April 25, 2023
 
As we discussed yesterday, earnings estimates have been dialed down, with Wall Street expecting a 6.7% contraction in S&P 500 earnings for Q1, in a quarter where the Atlanta Fed is tracking GDP growth at 2.5%. 
 
That said, we’ll get an update to that Atlanta Fed growth projection tomorrow, and we’ll get the first government estimate for Q1 GDP on Thursday.  But clearly, there is potential here for someone to be wrong.  
 
And at the moment, it looks like it’s Wall Street.  Today we had another day of big positive surprises on the earnings front.  And in many cases, revenues have come in higher than expectations too.  
 
Microsoft.  3M.  Google.  Biogen.  Chipotle.  GE.  McDonald’s.  Kimberly Clark.  Visa.  GM.  Haliburton.  Pulte.    
 
The broad economy is well represented in these stocks.  All beat earnings and revenue estimates.
 
It was a record quarter for Chipotle.  Microsoft, a $2 trillion company, had record revenue and record net income.  Pulte Homes grew revenue by 12% compared to Q1 of last year, with 28% EPS growth … despite being faced with the fastest doubling in mortgage rates on record.
 
This all sounds pretty good. 
 
What about the renewed fears surrounding banks, that led to this today …
Remember, First Republic Bank (FRC) was one of the three vulnerable banks (high uninsured deposits, large duration risk) that were harmed by a run on deposits last month.  Two failed, but FRC was preserved via an infusion of deposits from a consortium of big banks (arranged by the Treasury).   They reported yesterday after the close, and divulged the exit of half of depositor assets in the run (excluding the Treasury arranged infusion). 
 
With that, stocks (and interest rate markets) behaved today as if a banking shock might be turning into a banking crisis. 
 
But remember, the Fed is back in the business of expanding the balance sheet (QE).  They've given banks unlimited access to short term liquidity to meet demand of depositors (a crisis averting backstop).
 
That said, after doing nearly $400 billion of QE in March, as the fears quelled, the balance sheet shrank for the past four consecutive weeks (as you can see in the chart below, to the far right).
After today's events, I suspect we'll find the balance sheet is expanding again.   

 
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Pro Perspectives 4/24/23

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April 24, 2023
 
It's a big earnings week.  
 
As we discussed coming in to this earnings season, expectations have been dialed down.  That creates an opportunity positive surprises.    
 
With that, coming off of a major shock and potential broad threat to banks last month, the first hurdle to clear, in this Q1 earnings season, was the big banks. 
 
That was done successfully.  The big banks posted big earnings beats, even AFTER adding to their respective war-chests of loan loss reserves.
 
We've since heard from the, perceived-to-be, more "at-risk" regional banks — including those that share the threatening combination of high uninsured deposits and large duration risk (characteristics akin to the bank failures of last month).  The good news:  We've seen a fair share of earnings beats in those reports, and cases of muted or successfully tamed deposit flight.  
 
Overall, better than half of the companies that have reported in the financial sector have beat earnings estimates, thus far.  
 
More broadly, in quarter where the bar was set very low for earnings expectations, 76% of S&P 500 companies that reported as of Friday had beaten expectations. 
 
That said, this week, we'll hear from big tech companies, along with broader corporate America.
 
Keep in mind, these earnings are from a quarter that the Atlanta Fed continues to project GREW at a 2.5% annualized rate.  That's in contrast to Wall Street's expectations for a 6.7% contraction in earnings for S&P 500 companies — which would be the biggest decline since the depths of the covid shutdown. 
 
With this setup, we enter the heart of earnings season with sentiment readings leaning bearish.  Speculators are net short S&Ps at levels not seen since October 2011 (when the European sovereign debt markets were in crisis).  And the Bank of America global fund manager survey shows most bearish on stocks, relative to bonds, since 2009.  
 
These tend to be contrarian indicators. 
 
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